FINRA proposed amendments to the capital acquisition broker ("CAB") rules to widen the scope of firms eligible to operate as CABs and to make certain changes to the regulatory requirements applicable to CABs.

According to FINRA, the proposed amendments would do the following.

  • Permit CABs to act as investment advisers if their only advisory clients are "institutional investors."

  • Permit a CAB that privately places an issuer's securities to agent secondary transactions of those securities between "institutional investors," in accordance with an exemption from registration under the Securities Act of 1933.

  • Expand the definition of "institutional investors" to include the "knowledgeable employees" of a private fund or issuer to which the firm provided CAB services. For this purpose, "knowledgeable employee" would be defined in accordance with Investment Company Act Rule 3c-5. Currently, "institutional investors" are defined in CAB Rule 016(i) to include "qualified purchasers," as defined in the Investment Company Act, certain regulated entities and employee benefit plans, and institutions and individuals with at least $50 million in total assets.

  • Codify FINRA guidance permitting a CAB to receive compensation, in the form of securities issued by a privately held CAB client, instead of cash.

  • Adopt CAB Rule 321 ("Supervision of Associated Persons' Investments") to require CABs whose corporate finance or private placement activities pose insider trading risks to implement written procedures to mitigate those risks, including compliance with the transaction review requirements of FINRA Rule 3110(d), and the personal account trading requirements of FINRA Rule 3210.

Comments on the proposal must be submitted by March 30, 2020.


FINRA's proposal seeks to widen the scope of firms that are eligible to operate as broker-dealers under the regulatory-lite regime for CABs. The proposal is likely to be of particular interest to private fund advisers and private placement agents.

Private fund advisers that are not registered with the SEC as broker-dealers generally sell securities of funds they advise either (i) through third-party brokers, which charge brokerage commissions for their sales activities, or (ii) internally, through sales of fund interests in a manner that falls outside the scope of broker-dealer registration, in which case the adviser may not charge brokerage commissions for those sales. Under the FINRA proposal, advisers to private funds falling within Section 3(c)(7) of the Investment Company Act (whose investors are limited to "qualified purchasers" and "knowledgeable employees") should be eligible to register as broker-dealers and operate under the CAB regime, thereby enabling them to charge brokerage commissions for sales of fund interests and to compensate their employees for such sales. By contrast, investment advisers to funds falling within Section 3(c)(1) of the Investment Company Act that are not limited to "qualified purchasers" and "knowledgeable employees" would not be eligible to register as CABs in order to sell interests in those funds, as investors in 3(c)(1) funds would not be limited to "institutional investors" under the CAB Rules.

Private placement agents that engage in secondary sales of securities are not currently eligible to operate under the CAB regime (unless those secondary sales are in connection with a change of control of a privately held company). FINRA now proposes to expand the CAB regime to permit a firm that privately places an issuer's securities to agent secondary sales of those securities in private transactions between "institutional investors," including "qualified purchasers" and "knowledgeable employees."

Benefits of CAB status: The current CAB regime has attracted only 55 firms. By contrast, FINRA estimates that there are currently approximately 700 SEC-registered broker-dealers that conduct "CAB-like" activities, but that have not elected to operate as CABs. FINRA presumably hopes that the proposed expansion in the scope of permissible CAB activities will induce private placement broker-dealers that conduct secondary sales of privately placed securities to elect CAB status, and qualifying private fund advisers that are not currently registered as broker-dealers to register as CABs. FINRA notes that firms operating under the CAB regime are not required to conduct branch office inspections, and are subject to more lenient requirements applicable to broker-dealer communications and AML audits.

The question is whether the increase in the scope of eligible securities activities, coupled with the more lenient regulatory requirements, provide a sufficient incentive for firms to operate as CABs. FINRA requests comment on this question, and whether there are other categories of activities that should be incorporated into the CAB regime. For example, it is difficult to see the objection to an investment adviser with non-institutional advisory clients registering under the CAB regime provided that any private fund sales activities are restricted to institutional investors. In addition, FINRA should clarify that a CAB may conduct discretionary investment advisory activities notwithstanding the current prohibition in CAB Rule 016(c)(2) on a CAB exercising investment discretion on behalf of a customer. It would also be useful for the definition of "institutional investor" to expressly include an entity that is wholly owned by "institutional investors." More broadly, this is a good opportunity for private fund advisers and private placement agents to consider the merits of CAB registration, and whether additional changes to the CAB regime would make it more appealing.